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MIXING OIL AND WATER: IRS ALLOWS HSA TO CO-EXIST WITH FSA

November 28, 2005

When the Treasury allowed cafeteria plans to allow participants until 2 1/2 months after year-end to use up their prior-year Flexible Spending Account (FSA) savings, it created a problem for Health Savings Accounts (HSAs). If you are participating in an FSA, you can't also qualify for an HSA. The 2 1/2-month "grace period" could cause problems for employees switching to high-deductible health plans with HSAs on January 1, 2006.

The IRS issued a notice last week (Notice 2005-86) that will allow cafeteria plans to use the 2 1/2-month grace period without disqualifying HSAs at the beginning of 2006. They also explain what happens if they leave the cafeteria plans as they are.

The choices offered by the Notice:

1. Do nothing. If a cafeteria plan for 2005 has the grace period, and the employee switches to a high-deductible health insurance plan for 2006, the employee would be ineligible to contribute to an HSA for the first three months of 2006.

2. Mandatory Conversion to HSA-compatibe FSA. This would require amending the cafeteria plan to get rid of all benefits not compatible with the HSA for the grace period (in short, any health-related benefits).

Transition relief for 2006. For plan years ending before June 5, 2006, taxpayers won't be disqualified by a grace period if they spend all of their own and their spouses 2005 contributions by December 31, 2005, or if the employer amends the cafeteria plan to exclude those with high-deductible plans from the grace period.

Links:

BenefitsBlog Coverage
Treasury press release on Notice 2005-86
HSA Coalition guide to HSAs

InsureBlog's series on HSAs

Part 1
Part 2
Part 3
Summary

Tax Update prior coverage:

THE NEW HEALTH SAVINGS ACCOUNTS: HOW THEY WORK
TREASURY PROVIDES COMPREHENSIVE HEALTH SAVINGS ACCOUNT GUIDANCE